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Estate planning health check

With end of financial year compliance now wrapped up, many practitioners are turning their attention to estate planning concerns. Cooper Grace Ward Lawyers partner Scott Hay-Bartlem flags some of the key aspects that should be reviewed.

What needs to be reviewed with trust deeds?

It’s a good time for everyone to look at documents like trust deeds for SMSFs. Lots of trust deeds still have issues with things like binding death benefit nominations and reversionary pensions and don’t deal with them well, particularly if they’re older ones. One of the issues I’m really seeing at the moment is that there’s a problem with an old change of trustee or an old variation hasn’t been done properly, and that can call into doubt later decisions. Certainly, things like pensions and binding death benefit nominations, and other death benefit planning can go awry because we don’t have an early document done properly. There was a case last year called Perry v Nicholson where an old change of trustee nearly derailed the estate planning, so it’s important to make sure you’ve got all your documents lined up from the past.

Following the introduction of the transfer balance cap and other super reforms, what are some of the estate planning strategies that need to be reviewed?

Everyone with money in super certainly should be reviewing their estate planning following the budget reforms for a couple of reasons.

Firstly, it’s always good to make sure that what you’ve done is what you remember you did, and it’s still current and effective because things change all the time. Also, with the new limits and transfer balance cap, the option that we used to have of just continuing the pension to the surviving spouse may no longer be there, and that means you may need to look at some alternatives to get the best estate planning results for the client.

We’ve certainly seen files from three years ago, where there was an estate plan set up with a great result, but because of the new limitations on how much we can have in pension phase, we’re not going to get that result we had anymore, and we need to do something differently and tweak the plan to continue getting the best result. With some clients, when we look at the old estate plan, we decide that we’ll have to do it differently, but what we set up initially is still going to work for us. With other clients, it’s clear that one of the other options is going to achieve a better result now, because we can’t do what we used to do.

Strategies such as binding nominations or reversionary pensions, for example, that force all the super to the spouse may not be the best answer or doable. Some clients will have to have a large amount of money leave the superannuation system when one of them dies. For example, some of the old estate planning that was done sent all of the money to the spouse, because you could with a pension. Now, it has to leave the super system as a lump sum. So, we’re now asking questions around whether it’s better to put that into the estate and have it go into a testamentary trust in order to create almost like a life interest for the spouse, so that it must go to the kids once the spouse has died. Rather than having $1 million come out of the super system and end up in the name of the surviving spouse, we have it go through the will and into a testamentary trust. That can provide some tax benefits to the adult children and their minor grandchildren. It may also give protection from a lawsuit that the spouse might be subject to, because they have professional or business risk. It might also provide protection if the spouse re-partners. So, for some people, having that as an alternative can be a better option than having it come out of the super system and end up with the spouse. If you’ve got a binding nomination to the spouse or reversionary pension that forces it all to the spouse, then we’re going lose that kind of option.

For some clients, we’re skipping the spouse altogether, and we’re planning to send the lump sum amount to the adult children or the young children. May not be as tax effective initially, but where the surviving spouse has enough money or the client is concerned about them repartnering or business risk issues, that can be an effective alternative to just forcing the super to go to the surviving spouse.

We’ve done a few reviews of clients from 2011 and 2012, back when the ATO came out with the tax ruling that said a pension stopped when you died, and, therefore, you lost the tax exemption for the income from the assets that were supporting the pension unless you forced it to continue to the surviving spouse. So, we’ve got a whole lot of estate planning from that era where, again, it forces it to the surviving spouse as a pension. That’s not always going to work anymore, and those strategies are ones that really need to be reviewed to make sure it’s still going to work for us. If the client is happy for their spouse to have the money and the choice, then they may not need a binding death benefit nomination anymore. They may want to give their spouse the flexibility of choosing an estate with a testamentary trust, or paying it to the kids or themselves, if they want to. They may not want the pension to revert to the surviving spouse because of the limits on the amount that they can take as a pension, and there’s going to be amounts coming out as lump sums.

The other side of it too is that in many cases, the structure of an SMSF will have changed. Those who once just had a pension interest now have a pension and a lump sum interest. So, they might have been relying on a reversion to pass all their super through to the spouse, but they’ve now got an accumulation interest as well, so they will need to do a binding death benefit nomination for that. Therefore, we need to look at whether the current arrangements, whether that’s binding nomination or a reversionary pension, are still appropriate and support the estate planning outcome. It might be the super fund itself has changed, and what we used to do is not going to get us the result anymore.

Is there anything else that should be reviewed on the estate planning front?

We’re still seeing lots of files where someone comes to us after a death with what they think is a reversionary pension or a binding death benefit nomination, and for a variety of reasons, they’re not. It’s a good time to do a health check. Look at all the documents and deeds, and make sure they still get the client the result.

I see lots of people with the old pensions, because often it’s hard to find pension documents from 1996 that are now well over 20 years old – so it’s a good time to make sure you know where those documents are, because, eventually, you’ll need to see these pension documents.

These days, with technology, we scan everything in, but back in the mid-90s, we didn’t do that, so putting hands on documents that are 20 years old can be a challenge. If we’re trying to establish that the pension automatically continues because it’s reversionary, we’re going need to see the pension documents, so if no one can find the pension documents, we can’t establish there’s a reversion, or it’s very hard to establish that there’s a proper reversion in place.

I also still haven’t seen many people embracing child pensions. I think with transfer balance caps, limiting the amount that can often go to a surviving spouse, it’s important to remember that there can be benefits in paying benefits to children as pensions. A child pension has to finish effectively at age 25, but if you’re looking at children under age 18 or even 25, or disabled children, they can be a good strategy for those categories. It’s not going to work for everyone, but you should be conscious that it’s there as an option.

Source: SMSF Adviser

Australians not prepared for ‘largest’ transfer in history

Despite being the largest transfer of intergenerational wealth, the vast majority of Australians are not prepared, according to new figures.

Perpetual has revealed that 76 per cent of Australians do not have a current will, while 53 per cent of parents have not discussed their will and legacy with their children.

Perpetual Private’s Andrew Baker, general manager of private clients, believes the majority of parents wish their children would use their inheritance wisely and build for the future, but research shows the opposite is happening.

He conceded, however, that the rising costs of living, slow wage growth and a volatile property market is painting a different picture of wealth today than it was 30 years ago.

“It is estimated that 70 per cent of families will lose their wealth by the second generation and 90 per cent will lose it by the third,” said Mr Baker.

To offset risks of families losing their wealth, Mr Baker advocates for discussions around wills and inheritance be broken down so all parties can be prepared and have a plan in place.

“As humans, we tend to shy away from discussing money amongst our families and friends.”

“However, as we approach the largest intergenerational wealth transfer in history with more than half of Australians expecting to inherit, why have only just over a third discussed their wishes with their children?” Mr Baker said.

The wealth manager believes normalising discussions around money and the future can preserve wealth across generations.

Source: SMSF Adviser

Tax Institute calls for delay to enforcement of NALE rules

The Tax Institute has called for enforcement of changes to non-arm’s length expense (NALE) rules to be delayed until 1 July 2020, suggesting the ATO’s interpretation of the laws should be referred to its General Anti-Avoidance Rules (GAAR) panel as the powers handed to the regulator are too broad.

In a submission to the ATO this week in response to its Draft Law Companion Ruling 2019/D3, which outlines the ATO’s interpretation of the NALE laws, The Tax Institute suggested compliance guidelines released with the ruling, which indicated resources would not be allocated to policing the general expense provisions until the 2021 financial year, should be extended to all SMSFs caught by the changes.

“The PCG should apply across the board to any taxpayers where the ATO seeks to apply the new NALI/NALE provisions for any of the FY2019 and FY2020 periods,” the institute said.

“The Tax Institute rejects the ATO’s position that the PCG be limited so as to apply only in the instance where a general expense taints all the fund’s income.

“We recommend that given the delay in introducing the NALE reforms, the ruling in relation to the NALE measures only take effect from 1 July 2020.”

The institute warned that the ATO’s ruling had “serious ramifications” for many SMSF trustees because of the degree to which “substantial adverse tax implications” could result from small matters, such as an accountant assisting with their own fund’s tax returns, and as such should be reviewed to the GAAR panel before it was applied to any taxpayer.

Tax Institute Superannuation Committee member and DBA Lawyers director Dan Butler said the ruling as it currently stood gave the ATO “very broad power” and could result in affected clients being caught up in costly long-term legal battles to fight excessive assessments from the ATO.

“In some circumstances, it takes years of information gathering and correspondence with the ATO to work through these matters, and it inflicts great costs on the taxpayer to prove that the NALI assessment is excessive,” Mr Butler told SMSF Adviser.

“We don’t like that the legislation has provided the ATO a lot of discretion. There is not much protection for a taxpayer, and to get the system right, there should at least be independent representation given to the ATO’s GAAR panel which then decides whether to pursue a NALI assessment, because of the costs and the consequences that follow.”

Clarification needed around who will be caught

The Tax Institute also suggested in its submission that the ATO provide more specific clarification around which trustees would be caught by the rules, by applying a “de minimis” principle and providing guidance around which activities constituted trustee and non-trustee services.

Mr Butler said the industry would benefit from guidelines about what constituted a “material” expense, which could also reduce the administrative workload required from the ATO to police the laws.

“Why are we talking about expenses at $100? The administrative side of it is too great,” he said.

“We need a guideline from the ATO to say we won’t go looking for bits and pieces, it’s material items. Let’s say an administration service may be $2,000 a year — I would consider that immaterial, so perhaps it should be above $20,000. You need a benchmark where people can say we’re above the limbo bar.”

Equally, while the ruling mentioned the distinction between services performed in a trustee capacity or an individual capacity as a key factor in whether an expense would be considered non-arm’s length, Mr Butler said there needed to be clearer guidance as to what these services were.

“In the ATO’s 2013 NTLG super committee minutes, the example they gave of when something becomes a non-trustee service was a builder, because it’s someone who’s got specific skills and they are adding a lot of material value to the fund,” he said.

“The ATO may say as an adviser you have investment skills, but because the adviser is a trustee and under trust law they have to do the best for the fund, it’s hard to start splitting hairs about what is their role as a trustee and what is their role as a planner.”

Catch-up contributions can release assets from defined benefit pensions

New catch-up contribution rules can be used to assist clients with large amounts of assets locked in to defined benefit pensions, according to Colonial First State (CFS).

Addressing SMSF Adviser’s recent SMSF Summit 2019 in Perth, CFS executive manager Craig Day said the new rules, which allowed fund members to access unused concessional contribution balances up to five years ago, could be used to reduce sometimes large reserves of assets stuck in defined benefit pensions for older clients.

“If the client’s got no other concessional contributions, you can allocate up to the cap, which is currently $25,000, but the interesting thing about the concessional catch-up rules is you get [access to] those rules regardless,” Mr Day said.

“If a client hasn’t worked for 20 years, what level of salary sacrifice and SG contributions has he got? Zero. So, all these clients are accumulating unused concessional cap amounts of $25,000 a year and a client’s concessional cap may be up to $100,000.”

Mr Day said CFS was receiving an increasing number of calls from advisers who were concerned about what to do with clients that were advancing in age and had large amounts of assets locked up in defined benefit pensions.

“If your clients did commence one of these fixed term defined benefit pensions, they could only be one of two types: a lifetime, and the people are dying; or a life expectancy, and you’re getting to the end of the term,” he said.

“The ATO has told us that if the person dies or the term comes to an end, the assets backing that pension don’t belong to that member, they simply fall into a reserve. If you want to get that back to the members, you’ve got to allocate it out of the reserve back to members’ accounts, and if it goes above 5 per cent, you have an amount counting towards the concessional cap.”

Mr Day said for some defined benefit pension types, part of the pension could be commuted into a term allocated pension without counting as a contribution.

“There’s a strategy that simply involves rolling over to commence a complying term allocated pension, and if you do that, the allocation will not count towards the concessional cap, but there are some catches here,” he said.

“If you’ve got one of the non-complying defined benefit pensions or a complying life expectancy, the commutation value is limited — it might give you $100,000, but the amount of assets you’ve got sitting on reserve is $200,000, so you can only allocate $100,000 that doesn’t count towards the caps.

“With the lifetime pensions, there is no commutation and that can make a massive difference.”

Source: SMSF Adviser

NALI ambiguity dealt with by ATO

Non-arm’s length income (NALI) determinations from the ATO must crop up now and then in SMSF trustee nightmares, particularly in regard to LRBAs.

While the NALI provisions are an accepted anti-avoidance measure designed to stop income that would otherwise attract the top marginal tax rate being directed to an SMSF, they are coming under more and more scrutiny from the regulator due to the tax revenue potentially skirting legitimate collection.

In this regard, trustees and practitioners should note that there is new legislation that seeks to draw even tighter the operating rules on NALI with a focus on the expenditure side of transactions.

Treasury Laws Amendment (2018 Superannuation Measure No. 1) Bill 2019 has now passed both houses of Parliament. This amends NALI provisions in the income tax law to specifically include non-arm’s length expenses. Note that LCR 2019/D3 and PCG 2019/D6 will aid understanding of the new rules greatly.

The EM to the legislation provides examples of where either an SMSF’s expenses are less than what would have been incurred had the parties been dealing at arm’s length, or there is no loss, outgoing or expense incurred by the SMSF where some would have been expected if the parties had been dealing at arm’s length. In these situations, the income earned by the SMSF is treated as NALI and taxed at the highest rate.

In short, the bill clarifies the operation of Subdivision 295-H to make sure that SMSFs and other complying superannuation entities cannot circumvent the NALI rules by entering into schemes involving non-arm’s length expenditure (including, as noted, where expenses are not incurred).

Note also that any capital gains from a subsequent disposal of an asset may also be treated as NALI. The former law might not have applied to net capital gains in line with the policy intent of Subdivision 295-H. For example, a fund acquires an asset at less than its market value through non-arm’s length dealings and then disposes of the asset for market value consideration.

The resulting net capital gain may arguably be the same as the gain that would have resulted had the parties been dealing with each other at arm’s length when the asset was acquired, due to the operation of the cost base market value substitution rules in section 112-20.

This meant that the former non-arm’s length income rules may have had no effect, even though the transaction diverts more wealth into the concessionally taxed superannuation entity than would have been possible had the relevant dealings been at arm’s length. The new bill aims to rectify this.

The EM provides an example of non-arm’s length expenses:

An SMSF acquired a commercial property from a third party at its market value of $1,000,000 on 1 July 2015.The SMSF derives rental income of $1,500 per week from the property ($78,000 per annum).

The SMSF financed the purchase of the property under limited recourse borrowing arrangements from a related party on terms consistent with section 67A of the SIS Act. The limited recourse borrowing arrangements were entered into on terms that include no interest, no repayments until the end of the 25 year term and borrowing of the full purchase price of the commercial real property (that is, 100% gearing).

The SMSF was in a financial position to enter into limited recourse borrowing arrangements on commercial terms with an interest rate of approximately 5.8%. The SMSF has not incurred expenses that it might have been expected to incur in an arm’s length dealing in deriving the rental income.

As such, the income that it derived from the non-arm’s length scheme is non-arm’s length income. The rental income of $78,000 (less deductions attributable to the income) therefore forms part of the SMSF’s non-arm’s length component and is taxed at the highest marginal rate.

However, there will be no deduction for interest, which under the scheme was nil. Non-arm’s length interest on borrowings to acquire an asset will result in any eventual capital gain on disposal of the rental property being treated as non-arm’s length income.

Source: Tax & Super Australia

How to pass the sole purpose test

Making sure an SMSF passes the sole purpose test (SPT) is one of the cornerstones of operating a compliant SMSF. One of the most important things to understand is that it’s not the type of investment dictating whether the SPT is met, but rather the purpose for which the investment is made and maintained that is relevant.

This is crucial given that the trustee and member are typically the same people, which can give rise to conflicts of interest when critical financial decisions need to be made.

What is the SPT?

The SPT is not an actual test, but more a rule of thumb where the fund must be able to demonstrate that it meets one or more core purposes at all times. The fund can also meet an ancillary purpose, but only if it also meets one or more of the core purposes at the same time.

In broad terms, section 62 of the SIS requires that any or all of the following core purposes must be met to provide benefits to members:

  • retirement
  • reaching age 65
  • death

Generally, where a current day benefit is provided to a member as a direct result of actively procuring that benefit, then s62 SIS will be breached.

The ancillary purposes, which must co-exist with one or more of the core purposes, are:

  • Termination of employment
  • Cessation of work due to ill health
  • Death or reversionary benefits
  • APRA-approved benefits

Remember, too, that SPT is concerned with how a trustee of an SMSF came to make an investment or undertake an activity which can vary from trustee to trustee.

Role of the SMSF auditor

The role of the SMSF auditor is to ensure that the fund complies with the SPT during the year being audited. All of the circumstances of the fund must be viewed by the SMSF auditor holistically and objectively to determine whether the SPT has been contravened.

The auditor will look for factors that would weigh in favour of a conclusion that an SMSF is not being maintained in accordance with s62, such as:

  1. The trustee negotiated for or sought out the benefit
  2. The benefit influenced the trustee to favour one course of action over another
  3. The benefit is provided by the SMSF to a member or another party at a cost to the SMSF
  4. There is a pattern of events that amounts to a material benefit being provided

Nevertheless, when an SMSF receives a benefit that is incidental, remote or significant, it does not necessarily result in the fund contravening the SPT. SMSFR 2008/2 deals with the application of the SPT where members receive benefits other than retirement, employment termination or death benefits.

Sole purpose test penalties

Failure to meet the SPT is one of the most serious contraventions as it goes to the very core of the superannuation legislation. Aside from the risk of a fund being made non-complying and losing its concessional tax treatment, penalties can be applied up to $10,800 per trustee.

The ATO has the discretion to freeze an SMSF’s assets where it appears the trustee’s conduct is likely to have a significant adverse effect on the SMSF, and they also have the power to disqualify trustees.

The court can also impose a sentence of five years’ imprisonment for individual trustees or longer for corporate trustees.

Voluntary disclosure or wind-up?

Other courses of action the trustee can take to rectify an SPT contravention is to engage early with the ATO through their voluntary disclosure service or decide to wind the fund up.

Where the trustee chooses voluntary disclosure, the ATO may continue to issue the SMSF with a notice of non-compliance and/or apply other compliance treatments.

Impact of Aussiegolfa case

The traditional approach to the SPT is seen in SMSFR 2008/2, which states that the SPT is a strict standard with exclusivity of purpose.

The outcome of the Aussiegolfa case, however, has provided a deviation from this strict interpretation of the law, in that the SPT is now an objective test and assessment based on the facts and circumstances of each case.

The ATO has acknowledged there are other factors giving rise to incidental advantages to members or other persons which would not, necessarily, give rise to a breach of the SPT. All circumstances and objective assessment of the decisions and actions of the trustee are relevant in determining whether the SPT is breached.

The ATO is still reviewing the impact of the decision across other related advice and guidance products.

Conclusion

The SPT represents only 8.3 per cent of all contraventions, which may indicate that SMSF auditors are either reticent to qualify funds on this basis or do not understand how to apply the SPT.

Given that loans to members account for 21.4 per cent of all contraventions and in-house assets account for 19.1 per cent, there is obviously scope for SMSF auditors to more carefully monitor the intentions of the trustees in light of all the circumstances of the fund.

There are many holistic factors to consider when applying the SPT to the operations of an SMSF. All the circumstances of the fund’s activities need to be reviewed, with closer scrutiny applying to the actions of the trustees to ensure regulatory compliance.

Shelley Banton, head of technical, ASF Audits

Source: SMSF Adviser

ATO considers non-compliance notices for lapsed lodgers

The ATO may consider further action to spur on SMSF trustees to lodge their annual returns on time, including making funds non-complying where after repeated attempts to contact them they do not actively engage with the regulator around any problems preventing them from lodging.

Speaking at SMSF Adviser’s SMSF Summit 2019 in Brisbane on Tuesday, ATO assistant commissioner Dana Fleming said the regulator had written to all SMSFs who had failed to lodge a return for the first time and would take more serious steps if these funds did not engage with the ATO to rectify the situation.

“We have explained to them that by not lodging their return, their compliance status is at risk, and advising them of our early engagement and voluntary disclosure service, and to come forward if there’s a problem,” Ms Fleming said.

“If there is no response, we will consider writing to them and making them non-complying, and we are hoping that is a way for us to get them to engage.”

Ms Fleming pointed out that the non-complying status would not be permanent and would hopefully act as a more serious impetus for affected trustees to lodge their returns on time. If they subsequently engage and lodge, the notice of non-compliance would be immediately revoked.

“If we issue a notice of non-compliance, it only applies to the year in which you are made non-complying, so it would enable the person to come forward and rectify that situation before the next return is due,” she said.

Ms Fleming said “lapsed lodgers”, or those that had fallen behind after initially lodging their annual returns on time, made up over 10 per cent of the SMSF population, totaling 71,000 funds.

“They represent $44 billion of super according to their last return lodged, that we don’t know what is happening with,” she said.

She added that the reasons for lapsed lodgement commonly included the trustee encountering a “regulatory hurdle” by realising they had made a compliance breach and not being sure what to do next, or the more active member of the SMSF having passed away.

“We had one case where the trustee didn’t even know they had an SMSF, so it’s important to emphasise that all trustees are engaged with their SMSF, not just one,” Ms Fleming said.

Source: SMSF Advsier

Downsizer contributions offer more than meets the eye

Retiree clients looking to sell their property can often contribute more to their SMSF than expected through the government’s recently introduced downsizer contribution rules, due to the flexibility to split contributions between spouses and use them in conjunction with other contribution rules, according to Fitzpatricks Private Wealth.

Speaking at SMSF Adviser’s SMSF Summit 2019 event in Brisbane, the advice firm’s head of strategic advice, Colin Lewis, said it was possible for clients approaching their 65th birthday in particular to double their contribution amounts by making use of the downsizer and bring-forward contributions and potentially splitting contributions with their spouse.

“Clients must be age 65 at the time of contribution [to use downsizer], not when they sell the house, it’s when they wish to contribute the proceeds into super,” Mr Lewis said.

“So, when they sell the house they can be under 65, but if within a 90-day period they turn 65, they can make contributions, so it’s the timing that is the essence here if you are dealing with a client that is 64 and thinking of selling their home.”

Mr Lewis gave the example of Ron and Paula, who were 76 and 64, respectively, and planning to sell their $1.5 million home before Paula’s 65th birthday in December 2019. Ron had an existing account-based pension worth $1.6 million while Paula had $1 million in accumulation phase, and the couple had a joint investment portfolio worth $1.5 million outside super.

“On 16 October, they enter into a contract to sell their home for $1.5 million with settlement on 27 November,” he said.

“From the proceeds, Ron and Paula make the following contributions within 90 days: Ron makes a $300,000 downsizer contribution; prior to her 65th birthday, Paula makes a $300,000 non-concessional contribution; and after turning 65 she makes a $300,000 downsizer contribution and commences an account-based pension of $1.6 million.

“So, they’ve rearranged their affairs, they’ve now got a new house worth $1.6 million, Ron’s got an accumulation benefit worth $300,000, Paula’s got an account-based pension of $1.6 million, and their money outside super is $500,000. So, what they’ve been able to do is upsize, put more into super and make a downsizer contribution.”

Mr Lewis added that splitting contributions between a couple was another good way to make the most of the downsizer rules, given that a client’s spouse did not need to have been an owner of the property to use the proceeds for their contribution.

“The spouse doesn’t have to be on the title to contribute — with spouses, it all hinges on whether the owner of the property is eligible, and if they are, the spouse can contribute too provided they’re 65 or above,” he said.

Source: SMSF Adviser

ATO urges quick action on transfer balance caps

The ATO is urging SMSF trustees to take quick action around any excess transfer balance determinations or commutation authorities received in October to avoid any accidental non-compliance that could occur over the Christmas holiday period.

In an update posted to the ATO website on Monday, the office noted that any excess transfer balance determinations or commutation authorities issued to trustees in October would have due dates during the Christmas/New Year period, increasing the risk that trustees could accidentally fail to comply with such notices due to the holiday shutdown.

“We encourage SMSF trustees and members to respond early to this correspondence to avoid adverse consequences,” the ATO said.

“Commutation authorities need to be actioned by the due date to avoid losing access to the income tax exemption on the assets supporting the pension.

“If SMSF members don’t respond to excess transfer balance determinations by the due date, we’ll send a commutation authority to the fund specified in the determination.”

The office added that if an SMSF member had concerns about a determination issued, they or their tax agent could view the events making up their transfer balance account through the ATO’s online services.

“If any information is missing or incorrect, provide it or correct your reporting as soon as possible to allow us to revoke the determination,” the ATO said.

“If your member is concerned about information reported to us by another fund, they should discuss this with the fund.”

While the commissioner did not have discretion to grant an extension of time to respond to a commutation authority, members could contact the ATO by phone to request time extensions around excess transfer balance determinations.

Source: SMSF Adviser

Reversionary pensions v BDBNs: Advisers’ risks

There has been a number of commentators suggesting that if a pension reversion nomination conflicts with a binding death benefit nomination (BDBN), the pension reversion nomination prevails.

While we acknowledge the answer is not necessarily black and white, as it depends on a careful examination of all the relevant documentation and each supplier’s documents differ in certain respects, we recommend that advisers should be mindful that they are comfortable with the way the documents they use are drafted and that they understand the legal risk and implications of using those documents entails.

In particular, advisers should ensure the strategies in the documents they supply their clients are legally effective and are supported by relevant legislation, case law or similar authority. An adviser procuring a document, for instance, from a web-based supplier is implicitly warranting that it is suitable for their client’s use. Hence why advisers need to be careful on what document supplier they use. Naturally, merely using a non-qualified supplier (that is, not a law firm) exposes an adviser to risk.

Indeed (pun intended), if the SMSF deed is silent, there is a strong argument to say that the BDBN overrides any conflicting pension reversion nomination.

However, there are certain SMSF deeds that expressly specify that a pension reversion nomination (e.g. a resolution in pension commencement resolutions) prevails over any conflicting BDBN. In that circumstance, there is a fair chance that a pension reversion nomination may prevail over a conflicting BDBN.

 

This article focuses solely on this issue. More specifically, this article asks whether you actually want a situation where a pension reversion nomination prevails over any conflicting BDBN.

This article concludes that — unless you are a lawyer — a pension reversion nomination overriding a BDBN is risky and that you should not use this type of documentation as there are more practical options available (more about this soon).

Why is there, on first glance, an appeal for reversionary pension nominations overriding BDBNs?

We have heard from some accountants and financial planners (which we will refer to from here on as “advisers”) that they favour reversionary pension nominations overriding conflicting BDBNs. When we ask why they have that preference, they typically maintain that it will allow them to implement the following sort of situation:

  • they can document a pension that, upon death, reverts to a spouse, for example; and
  • they can then document a BDBN to cover the remainder of the member’s SMSF benefits, which the BDBN might direct to be paid to, say, the estate or perhaps to a child.

However, there is a risk that recommending this arrangement could amount to a crime and give rise to other risks.

Recall the rules about ‘engaging in legal practice’

Each jurisdiction prohibits non-lawyers engaging in legal practice. In Victoria, for example, the Legal Profession Uniform Law Application Act 2014 (Vic) (the “Act”) provides that (sch 1 s 10(1)):

An entity must not engage in legal practice in this jurisdiction, unless it is a qualified entity.

Penalty: 250 penalty units or imprisonment for 2 years, or both.

We note that the Act defines “entity” to include individual, an incorporated body and a partnership. Accordingly, if you are, for example, an adviser, this prohibition applies regardless of how your business is structured.

This then raises the question of what it means to “engage in legal practice”. Section 6(1) of schedule 1 to the Act provides that “engage in legal practice” includes practise law or provide legal services.

There is no “bright line” demarcating with exact precision where “practising law” begins and ends, and where the “provision of legal services” begins and ends. However, we are of the view that there is a real chance that an adviser is practising law and/or providing legal services if:

  • he or she determines how a client’s death benefits should be structured (e.g. a pension that automatically reverts to a spouse and the balance to a child or the estate); and
  • he or she documents such a strategy (e.g. drafting the pension documentation and completing a template BDBN for the client).

We are particularly of this view as implicit in the above is that the adviser probably has led their client to believe that there is no need for the input of a lawyer. Indeed, an adviser who has not recommended that their client have all the relevant documents and advice reviewed by the client’s lawyer to check they are legally effective and are consistent with the client’s legal and estate planning position, would have provided legal services as the documents affect the client’s legal rights and obligations.

What else can commonly go wrong in practice?

Consider an accounting or financial planning firm that provides pension commencement documentation.

Now assume that the adviser provides such documentation to SMSF members of a particular SMSF whose deed states that a pension reversion nomination will override any conflicting BDBN. The pension commencement documentation states, among other things, that the pension is reversionary in favour of the member’s spouse.

Now assume that one such member did in fact have a BDBN in place, which was in favour of their legal personal representative (i.e. estate). The member then dies.

The SMSF trustee wishes to pay the deceased’s death benefits to the spouse, based on the pension commencement documentation. The executor of the estate might assert that the adviser is liable to the estate as the deceased did not properly understand the effect of the pension documentation. The adviser could try to counter this by responding that they advised the member of all relevant rights and liabilities and then drew up the documentation accordingly. However, if this indeed occurred, there is a real chance that the adviser has contravened the Legal Profession Uniform Law Application Act 2014 (Vic). Again, this is a serious crime.

Alternatively, the adviser may claim that they did not advise the deceased of all relevant information, rights and liabilities but nevertheless drafted the pension documentation. If so, the adviser may well have breached its duty of care owed not just to the deceased, but also to the deceased’s dependants, executor and any beneficiaries of the deceased estate (see Hill v Van Erp (1997) 188 CLR 159 where a lawyer was liable in negligence to potential beneficiaries of a deceased client’s will). The adviser may be liable to them under, among other things, the tort of negligence for any loss, damages and costs suffered.

We also note that some have asserted that since SMSF members typically also consent to various information in order to be trustees, they are taken to know all relevant information. We consider it high-risk to place much confidence in such an assertion based on cases like Ryan Wealth Holdings Pty Ltd v Baumgartner [2018] NSWSC 1502, which illustrate that a judge may not hold a member/trustee/director to having a sophisticated level of SMSF knowledge. Also, there is no information regarding succession planning in trustee declarations.

Naturally, each of the above two choices is an unfavourable outcome.

If advisers wish to rely on a deed that provides priority to a reversionary pension nomination, they should undertake sufficient due diligence to ensure that they do not cross a prior BDBN or interfere with their client’s succession planning. This analysis also attracts the risks that the adviser engages in legal practice.

A practical solution

DBA Lawyers has long considered that there is a simpler practical solution, which is to have a deed that expressly states that a BDBN overrides any conflicting pension documentation. This overcomes the immediate need for an adviser to undertake the due diligence discussed above, which is associated with an SMSF deed that provides the reversionary pension nomination priority. Simply stated, documenting a pension under this type of SMSF deed does not impact a BDBN.

Moreover, BDBN templates typically come with new deeds or deed updates and product disclosure statements. Thus, members can prepare and finalise their own BDBNs without adviser input. Accordingly, if a member wishes to make a BDBN under an SMSF deed providing a BDBN with priority, it is more likely that a member would expect that to impact their estate planning and be more informed as:

  • there is usually a product disclosure statement or other relevant material that comes with a template BDBN, and
  • the formalities that accompany the execution of a BDBN (e.g. two independent adult witnesses).

If you are not a lawyer, you do assume risk if you prepare a BDBN without recommending the client obtain a lawyer’s input. We anticipate that some readers might roll their eyes at this comment and think “typical lawyers — trying to create ‘jobs for the boys/girls’”. However, it is a simple fact that each profession has its limits and professional indemnity cover typically excludes advisers acting outside them.

Thus, it is best practice for advisers to always recommend that their clients have their BDBNs and similar documents impacting their legal rights and obligations, especially their succession planning, reviewed by a lawyer.

Conclusions

There is — if the deed is silent — a sound argument under many SMSF deeds that the default position is that a BDBN will override a conflicting reversionary pension nomination. However, if the deed expressly states that the opposite will occur (i.e. a reversionary pension nomination will override a conflicting BDBN), this may be the case. However, if your SMSF clients have a deed that stipulates that a reversionary pension nomination will override a conflicting BDBN, each time you prepare pension documentation there is a real chance that you could be “engaging in legal practice” and exposed to other legal risks.

The safer solution is to have a deed that expressly provides that a BDBN overrides a conflicting pension reversion nomination. This avoids these risks when documenting a pension.

Manage your risk and do not expose yourself or your firm where your professional indemnity insurance cover is not available.

Written by: Bryce Figot, special counsel, DBA Lawyers
Source: SMSF Adviser